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Beware The Credit Bounce

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CREDIT BOUNCE
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Payment card reward schemes could be the unwitting victims of government regulation

When Rosie McLennan bounced her way to gold for Canada in the Rio Olympics, regulation of the payment card industry was probably not uppermost in her mind. Which is surprising, given the trampoline routine of the 27-year-old resident of Toronto typifies that of the modern consumer when it comes to banking fees: just when they go down in one area, they tend to pop back up somewhere else.

The recent spat between Walmart Canada and Visa has reignited the debate about interchange; the fee paid by a merchant to customers' banks when a payment card has been used for the purchase. It is, effectively, a price to be paid for the convenience, efficiency and relative safety of card payment systems.

Some observers contend that price (and by extension the interchange fee) is the sole determinant of consumer behaviour. It is undoubtedly a major driver, but it is by no means the only one. A recent survey reported a card's rewards programme was considered more important than the interest rate. Well-intentioned action to lower prices at the tills could actually harm an aspect of personal financing - the reward programmes - of more concern to consumers.

Diane Brisebois, President and CEO of the Retail Council of Canada insisted the reward programmes in Europe survived interchange fee regulation: "they did not disappear and they are as generous as they were" she says. But the evidence suggests otherwise. Capital One, a credit card provider, said such reward deals were "no longer sustainable" after the fee caps, which the UK Cards Association reckons has cost banks £750m a year from card transactions.

A Private Member's Bill tabled by Liberal MP Linda Lapointe (Rivière-des-Mille-Îles), backed by the Canadian Convenience Stores Association and the Small Business Council, retail bodies, seeks to grant the federal government the power to cap credit and debit card fees. Such caps exist in many countries around the world but Canada, so far, has declined to take this route. Instead, a five-year voluntary agreement between Visa and MasterCard has been operating for a year, obviating the need for government-imposed regulation.

Walmart has stated that it will stop accepting Visa throughout its 370 Canadian stores, citing the cost to their business of processing credit cards, which they put at $120m (albeit without breaking that figure down by specific companies). Other Canadian retailers likewise bemoan interchange fees as a significant cost of business. As most, if not all, the costs are passed on to the consumer, the issue impacts us all, whether we know it or not.

(Some critics suggest Walmart's action is aimed more at driving consumers to their own card scheme or soon-to-be-implemented electronic payment system - Walmart Pay - or simply as a bargaining tactic in their negotiations with Visa.)

Diane Brisebois, says fees are "too high for both retailers and consumers" and compares the 1.5% voluntary rate for credit cards in Canada with 0.3% in much of Europe. Any savings from a lower interchange fee will, she predicts, flow back to benefit the consumer through cheaper prices at the tills.

It all sounds good in theory. Possibly too good. The experiences of Europe, Australia and the United States suggest the expectation of immediate and lasting benefit to the consumer through government-imposed regulation is, unfortunately, flawed.

Primarily this is because such thinking fails to acknowledge that interchange is but one small part of the financial ecosystem that links banks, card networks, merchants and consumers. History has shown that fiddling with such a delicate and inter-connected system rarely ends well for the consumer.

The loss of revenue from lower interchange fees is usually paid for by the consumer through higher bank fees elsewhere (and there is evidence this is already starting to happen in Canada) or swallowed up by merchants before it even reaches consumers' pockets.

A research paper written by PERC, an economic think-tank, says that in the five years after Spain brought in regulations in 2005, consumer organisations there found merchant savings had not been passed on to the public and two billion Euros in additional credit card fees were levied on consumers. There was no evidence from Spain or Australia that pointed to a reduction in price level to reflect the lower merchant fees. Additionally, in a business survey conducted in the United States, 57% of merchants claimed they would not pass on all savings from a lower interchange fee to consumers.

There is further bad news from Down Under. The Reserve Bank of Australia (RBA) implemented interchange fee regulation in 2003. In a paper submitted to the RBA, CRA International, a commercial services firm, said annual fees for standard cards rose by 22% and similar fees for rewards cards increased by between 47% and 77% from 2001 to 2004. The study found no evidence that the payment system in Australia operated any more efficiently or that consumers derived any net benefit from the regulation imposed by the RBA.

Reducing the financial burden on consumers and business is a laudable aim. But the payment system structure is too complex for the blunt tool of interchange fee regulation to have beneficial effect only. Expensive unintended consequences are usually paid for by the consumer. And as the PERC paper concludes: "it may not be sound public policymaking to simply take on faith...that the results of policy will be beneficial". And up goes Rosie MacLennan again.